The Emergence of Universal Owners

Challenge, July, 2000 by James Hawley, Andrew Williams

Some Implications of Institutional Equity Ownership

What happens when financial institutions effectively own almost the entire economy? Their interests are the same as the the public at large, argue these economists.

IN THE United States the growth of institutional investors (public and cooperative pension funds, corporate and union pension funds, mutual funds and bank trusts) over the past twenty-five years has concentrated a substantial amount of corporate equity in the hands of a relatively small number of fiduciary institutions. [1] This change in the ownership structure from individuals who held about 75 percent of stock in the early 1970s to institutional owners that currently own almost 60 percent of the largest 1,000 U.S. firms reflects the growth of various forms of indirect ownership (e.g., mutual funds) and beneficial claims (e.g., pension funds) in the U.S. economy. It is estimated that at least 45-50 percent of all Americans currently have some form of direct or indirect beneficial ownership or other financial claims linked to institutional stock ownership. [2]

The beneficial claims on the assets of these fiduciary institutions are a form of indirect or mediated ownership because they represent claims to payments rather than alienable claims to the equity or debt instrument itself. Similarly, mutual funds represent merely a claim on residual gains (or losses), not on the actual stock certificate itself. Hence, ownership, and indeed private property in the corporate form, is rapidly being transformed into an institution in which agents represent agents in what can be quite long and complex chains between the firm at one end and the ultimate beneficial "owner" or claimant at the other. [3] Property and ownership increasingly have become bureaucratic and organizational while the rights and responsibilities of operational ownership (that is, investment decisions, proxy voting, etc.) increasingly reside in the hands of professionalized management teams operating as fiduciary intermediaries.

Following Robert Monks and Nell Minow, corporate governance activists and authors of Corporate Governance and the principals of Lens Inc., we argue that many of these large fiduciary institutions are "universal owners."

Their holdings are so diversified that they have the incentive to represent the ownership sector (and the economy) generally rather than any specific industries or companies. This endows them with a breadth of concern that naturally aligns with the public interest. For example, pension funds can be concerned with vocational education, pollution, and retraining, whereas an owner with a perspective limited to a particular company or industry would consider these to be unacceptable expenses because of competitiveness problems. [4]

The holdings of many institutions are a significant cross section of publicly traded stock (and debt) in the economy and, therefore, have the characteristic of representing the entire economy. [5] The political and regulatory implications of this historic shift are barely recognized.

Economywide Implications of Universal Ownership

The fundamental characteristic of a universal owner is that it cares not only about the governance and performance of the individual companies that compose its investment portfolio, but that it also cares about the performance of the economy as a whole. Simply put, the universal owner's concern with overall economic performance is the recognition that it "owns" the economy (typically, a highly representative sample of the economy) and, therefore, bears the costs of any shortfall in economic efficiency and reaps the rewards of any improvement.

The quintessential universal owners are the largest of the public and private pension funds because they have amassed investment portfolios that naturally comprise a broad cross section of the financial assets available for investment, and their objective--to provide pensions--naturally gives them a long-term perspective toward wealth maximization. As a result, these fiduciary institutions have a strong incentive to consider the overall, economywide economic performance when seeking to improve the returns on their investments. If size or an indexing strategy prevent them from trading in and out of the market, they must look beyond liquidating a position as a way to meet their obligations. [6] If they cannot sell, they must care.

Indeed, since the mid-1980s institutional investors have been doing exactly that. [7] Their first and most sustained foray into active ownership has been to direct their attention to traditional corporate governance issues such as poison pills and split voting rights in an attempt to eliminate impediments to the market for corporate control. They also have viewed these policies as an attack on the rights and abilities of owners (themselves, as professional representatives of the ultimate beneficiaries) to hold management accountable. By and large, institutional investors directed their attention toward individual companies in individual situations, but the general message was clear. They were going to protect their rights as owners. Unfortunately, while good governance campaigns made sense in the abstract, some institutions, notably the California Public Employees' Retirement System (CalPERS), quickly discovered that most owners were only concerned with the economic performance of their investments and had, at best, a mild interest in the way portfolio companies were governed. Their interest was particularly mild in the case of firms whose market performance was judged to be adequate (or even better than adequate). Also, by the late 1980s antitakeover statutes and the collapse of the junk bond market had largely put an end to the market for corporate control and the discipline of underperforming management that it provided. As a response, CalPERS, United Shareholders of America, the Council of Institutional Investors, and other shareholder rights groups began to target companies because of their poor economic performance. The same corporate-governance issues--augmented with calls to separate the positions of chairman of the board and the CEO, and for other boardroom reforms, notably increasing the number of independent directors--were used as points of leverage. However, everyone involved knew that the issue of concern was economic performance, not boardroom reform as such. The raw power of institutional investo rs reached a high-water mark when, in a short period in the early 1990s, the chief executive officers of a number of household-name firms such as General Motors, Westinghouse, and American Express were replaced with the help of institutional pressure. [8]